Aurizon Holdings Limited (AZJ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Aurizon Investor Call. [Operator Instructions] I would now like to hand the conference over to Mr. Andrew Harding, Managing Director and CEO.

Good morning, and thank you for joining the call following on from this morning's announcement regarding the growth of our containerized freight business and 11-year contract with cornerstone customer Team Global Express. Although, we don't typically host the call following on some contract developments, given this announcement comes soon after last week's results, we want to update our investors accordingly. We are based in Brisbane today, therefore, I acknowledge the traditional custodians of this land, the Turrbal and Jagera people, and pay my respects to the Elders past, present and future, for they hold the memories, the traditions, the culture and hopes of Aboriginal Australia. We must always remember that under the ballast, sleepers, rail systems and office buildings where Aurizon does business was and always will be traditional Aboriginal land. I'm joined on the call by CFO, George Lippiatt; and Clay McDonald, Group Executive Bulk. The purpose of this call is to go through this morning's announcement before turning to questions. However, before I start, we were also pleased to announce this morning that following on from the approval of -- by the ACCC, the sale of East Coast Rail completed on Friday. Turning back to today's announcement. That is a significant milestone in the growth of our containerized freight business. Those on the call will be aware that we already haul containerized product across our bulk operations, including a hook-and-pull service in Queensland, containerized bulk commodities and containerized freights in Bulk Central. Today's announcement builds upon this service offering and is supported by both the Bulk Central infrastructure and a cornerstone customer. At our results presentation last week, we flagged the opportunity in containerized freight, driven by both domestic opportunities and accelerating global containerized freight trends. Today's announcement sees us begin to realize this domestic opportunity. As noted in this morning's statement, Aurizon has been awarded an Australia-wide 11-year contract with Team Global Express, formerly Toll Global Express. This contract is the delivery of rail linehaul services connecting Perth, Adelaide, Melbourne, Sydney and Brisbane. This is our biggest non-coal revenue contract ever, and Aurizon is delighted to be TGE's rail provider for its containers transported in the state. The contract delivers to Aurizon a high-volume contracts with a Tier 1 customer closely matched to our national footprint. The contract includes 5 weekly rail services East-West, Melbourne-Sydney-Adelaide-Perth, and 2 North-South, Brisbane-Sydney-Melbourne. As a cornerstone customer, TGE will account for approximately 70% of the capacity of these services based on TGE's historical volumes. In addition, there will be an opportunity for Aurizon to build on this strong foundation and increase volumes through additional customer growth to meet the fully installed capacity of these services of more than 200,000 TEUs. Services for TGE will commence in April 2023 with a ramp-up to a full service offering over the following 12 months. In July last year, we acquired One Rail Australia, which includes a major bulk and container haulage business together with the 2,200 kilometers Tarcoola to Darwin railway. This acquisition has been a key enabler in Aurizon being able to deliver a national service for customers such as TGE. Aurizon is well positioned to expand its presence in a growing market and demonstrate the many strong competitive advantages of rail, including cutting greenhouse gas emissions and congestion-busting in our towns and metropolitan areas as more freight is moved from road to rail. As I outlined in the results call last week, the containerized freight opportunity is not about Aurizon getting back into full-service Intermodal as some in the market have claimed. Our previous Intermodal business was not optimal, because it involved full end-to-end service, including freight consolidation, a significant trucking fleet, last mile delivery and managing more than 600 customers. Furthermore, we did not have a customer scale, let alone the scale of TGE to support our services. The Intermodal business I shut down in 2017 was not a business suited to Aurizon's capability. Aurizon's core competency is safely transporting product on rail, primarily across long distances. Around 2/3 of capacity in our previous Intermodal service was in the North-South Brisbane-Sydney-Melbourne corridor, a market dominated by trucking. The remaining capacity was across the longer and far more profitable East-West market. The service offering today will see this capacity reversed with around 2/3 of capacity to be deployed on the East-West market with the remaining 1/3 on the East Coast market. As noted earlier, TGE product is expected to account for around 70% of the TEUs. That is 1 customer accounting for almost 3/4 of the capacity, which compares with the historic Aurizon Intermodal business that had a utilization of around 50% across over 600 customers. At our results call last week, we detailed estimated growth capital investment of $430 million across key bulk business opportunities, including -- spend today, and this included $320 million of rolling stock. Aligned with our approach in committing to capacity ahead of customer demand, around 50% of this identified rolling stock spend is expected to be used to support today's announcement. Beyond this previously identified spend, a further $120 million over the period FY '23 to '25 will be deployed on terminal infrastructure and containerized freight wagons. As such, the total estimated spend on key growth projects is now $550 million, including the $200 million spend to-date. In terms of FY 2023, our growth capital estimate of $210 million was provided in the first half 2023 results. As a result of this announcement, this figure is now estimated at $250 million. Let me finish by saying how excited I am to be making today's announcement in expanding our presence in the containerized freight market. As I said earlier, this is our biggest non-coal revenue contract ever, and we are delighted to be TGE's rail provider for interstate rail transport. It is another step in achieving our ambition to double the earnings of our bulk business over the decade and to deliver sustainable growth in non-coal areas of our company. I look forward to further building upon the bulk growth platform. I will now take any questions.

[Operator Instructions] Your first question comes from Matt Ryan with Barrenjoey.

First question just asking about the contract and what sort of volume protections that are being built into it? And then just following on from that, it looks like TGE will account for about 70% of the capacity. Can you just help us understand whether that 70% gets you to return hurdles for an investment of this type? Or do you sort of require business on top of that in order to achieve what you're looking for?

Okay. Thanks, George, I might get you to talk about the return on investment.

Sure. I will do the second question. So Matt, first thing I'd say is this contract in isolation is profitable for us. In terms of our return hurdles, both an IRR of more than 10% at a ROIC of greater than 10% you need utilization of the gross capacity of somewhere between 75% and 85% to hit that level. But the range, though, that I've given depends on whether it's TGE or third-party volume. So that's probably the best I can do without speaking about specific customer contract items.

And the volume protections?

So this contract doesn't have the typical take-or-pay.

That helps. And then going back to the 2017 review, which I think was at the start of your sort of 10 year [indiscernible] -- sorry for that.

Yes, they're not coming to me, Matt.

That's good to know. I think at the time you sort of talked about East to West being quite difficult, just because you didn't have the scale. So can you help us understand whether this type of contract gets you to the scale that you need?

Yes. And the answer is it does. I mean if I can give you some numbers, if you think -- if you look at that market when we were last serving -- we had over 600 customers, our trains were at best, I think, ever, was 50% utilized. So this is a train utilization around 70% with 1 customer. So I think that actually states the case for it.

The other thing, Matt, I think is worth noting is, this arrangement with a Tier 1 freight forwarder. So it's about them -- us servicing them to service their customers. So they have looked at this schedule, and now have said that the schedule suits themselves and their customers. And so it takes -- and if you look at how the volumes are flowing, they're flowing -- like Andrew said, 70% of that volume is going East-West, which is dominated by rail, and the rest is going North-South. So back in the previous Intermodal, we had 600 customers and we're looking to put additional customers there to build scale and to build frequency. This has been built around TGE and their customers.

And just last question. I mean a lot has changed since then, but I guess the yields across a lot of business has gone up a lot. Just curious on your assessment of how you think yields will sort of play out over the next few years?

George, might get you to do whatever you can do and to help with that answer this questions.

Yes. I mean. Look, it's a long-term contract, Matt. And as you'd imagine, with most of our contracts, the CPI flows through it. One of the things we have seen over the last 6 years or so, is there's a lot more demand for rail freight, particularly East-West and there is supply of capacity. And so I think TGE commented on that in their media release, and we've certainly seen that over the last 6 years.

Your next question comes from Anthony Moulder with Jefferies.

I want to ask on terminals, given the majority of this work is the East-West. What's the terminal solution that you have for Melbourne, given you've always had the limitations of North Dynon. And related to that, where are terminals that you have, will you only use for other capital cities, please?

Yes. Anthony. And look, what I'll say is we have a mix of terminals that are both owned by Aurizon and open access terminals on the East Coast of Australia. I'm not going to get into the specifics at this point in time.

The second question I had was around the capacity that Pacific National has added, and have obviously got plans to add additional capacity. As well as those new train sets that Qube has on order the 20 locos that they talked about back in October. So what impact are you expecting on returns going forward if the market continues to have that surplus capacity?

George, do you want to talk about that?

Yes. I mean I won't talk about specific competitors, Anthony, but I will say that one of the attractions of this is that the TGE contract is 11 years, and it's about 70% of capacity. So it's a great baseload and compare that with our old Intermodal business, where we had 50% utilization, and we had none of the big freight forwarders on our train. So we're starting from a very different point. In terms of looking forward, clearly, we want to provide great service to TGE, so they can grow their volumes on our trains, and we'll work with them on that. That's where our focus will be. I think the other point I'd add is that we're very focused on that East-West market, which we see as a natural rail market and which we see as needing additional capacity, there's demand for that capacity. That's where we're focused.

And lastly TGE announcement talked a lot about the green freight initiatives. What in this contract is specifically providing a greener haulage relative to what you were previously getting?

Anthony, as I understand it, is by the provision of capacity, specifically if you think about them operating around the 70% mark and having the ability to grow that volume, they can pursue customers with contracts for rail, because they have the ability to offer them rail capacity on a longer-term basis, which is different to the previous circumstances.

Your next question comes from Cameron McDonald with E&P.

So just circling back to the CPI comment that was made before, are there any other cost pass-through protections that we should be aware of?

Yes. I mean what I could say, Cameron, the difficult part here is it's a specific customer contract. So I don't want to get into detail on that contract. But what I would say is, it's typical of what you'd expect in a rail freight contract. So think about what we normally say as a pass-through around fuel, around access. This is typical in that regard.

And can you talk about the tendering process? So where have they -- is this a road-to-rail replacement? Is this a rail-to-rail replacement from another incumbent operator? And then what do you think is a startup player that convince them to go with you with sort of less experience in this space?

Yes. Look, I actually think, Cameron, that's the only people that you can actually ask that question sensibly of is TGE. What I can say is what I've said previously, and you've seen it with our contracts and our contract wins is price is always an important factor, but we win the contract on service and reliability.

So how do you provide comfort around service and reliability when it's a new service?

Yes. Sorry, I'll talk to -- I'll hand it over to Clay.

Thanks, Cameron. I guess to give some context, for this particular contract for us as the operators, we see it as is fundamentally what we do each day. We've got over 500 train starts a day. And if you think about containerized freight that we move, we're moving around 480,000 TEU per year. So we have the -- its core capability for the bulk business. It's point-to-point operations terminal to terminal. And so I guess that capability is not new to us such it's not new to TGE who then came to us and wanted to develop a solution really for them, but also a broader market solution, right? That's the first thing. The second thing is we've got a network today that operates, as I said, that 480,000 TEU across the nation across those 5 states that we operate. And so there's opportunity to sort of move freight around or to consolidate freight on some of these services and use some of the 30% of capacity that remains on those trains. And finally, I guess, we ran trains prior to Christmas. So there was an opportunity. There was the emergency that you guys are well aware of, and we're asked to stand up some of these type of trains and we started running them prior to Christmas. So they've seen the capability in our existing core business. We move a significant amount of containers today, and we've proven that we can do it in late 2022.

And just going back to the previous question, sorry, was any part of this road-to-rail replacement?

So what it provides given the 70% capacity on the railway service, it provides further capacity for a conversion of customers that are currently on roads because there is no capacity who would like to go to rail, because they desire it, but there was no capacity. So it's very much about got a strong theme of road-to-rail conversion over time.

But it's not on day 1?

And, as I said in the announcement, we'll be standing up the service from day 1. So it's definitely not from day 1. But as the services stood up and we get into the first full year of operation that it provides the opportunity at that point in time.

Last question for me. Just your previous comment that it is profitable at the 70% mark. At what line item are you referring to that profitability? And secondly, as part of that, presumably, given that it's my words, effectively a hook-and-pull like you're not operating the warehouses or things like that for TGE, should we expect the margin to be pretty skinny?

Yes. It's difficult to give you a specific answer without then giving smart people like you, the ability to back some specifics of the contract. What I'd say, though, Cameron, is that when I refer to profitability, I'm referring to the EBIT line. And I'm referring to it in steady state. So that's post ramp-up. In terms of margins, what we focus on is when it gets to that 75% to 85% utilization of the service, because that's what we think is very much achievable. And at that level, if you take the midpoint, that's about a 15% EBIT margin, which is consistent with what I talked about on the call last week.

Your next question comes from Justin Barratt with CLSA.

Congrats on the contract. Just first question. I just wondered, is there any option for either party to extend the contract beyond the 11 years?

Justin, yes, there is. It's dependent on a range of factors and performance being one of them. But 11 years in and of itself is a long period of time, so we're going to focus on the first 11 years right now.

That's fine. And then, look, you've provided some really good indication of what the deal means for your CapEx profile over the next couple of years. But I was just wondering if you could give us any indication of the impact it has on your OpEx profile between now when the contract is fully ramped up? I mean you spoke to sort of some OpEx to be spent or your OpEx being spent ahead of sort of winning significant contracts. Should we expect any change to the OpEx profile compared to what you sort of spoke to at the FY -- 1 half '23 result?

Yes, there will be a different increased operating cost just because there will be additional services we're panning out. In FY '23, there will be single-digit million additional operating costs, but we haven't changed our EBITDA guide. I won't though get into the specific line item of OpEx in FY '24 and '25 because you'll have to wait until we give guidance on FY '24 and '25 for me to do that.

Your next question comes from Ian Myles with Macquarie.

Congratulations. Look, just quickly, what's the sort of the current key volume rate East-West at the moment across the whole market?

Clay, you want to go first?

Yes. So Ian, again there's -- we think there's around 550,000 of this kind of freight going East-West today. We think in total, there's around $900 million to $1.1 million on rail nationally, and then I can get down into the road and rail splits on North-South, East-West, if you like. But 550 going East-West, we think.

That sounds good. And then does TEG get a priority to your capacity? Like I'm just seeing a Christmas time that they want to move extra boxes. Did they get a priority over that whole train link?

I mean TGE is our cornerstone customer, but this is also an industry solution. We want to grow into the final 30% of that capacity. And so we work TGE on how we do that?

Can they surge their volume?

Sure. Absolutely. We would...

So would they -- can they guarantee getting on...

Sorry, go Ian.

So can they guarantee getting on the train or they potentially have some of their volumes built if you don't have the capacity?

I probably won't get into the specific terms, but they have a profile that needs to be able to surge and we've got a solution that -- that needs for them to surge.

So that's not without moving, that's not without changing 5 trains per week?

There's a variety of things we can do. You understand the network we've already got in place, moving freight around stage. You can understand the train starts we've got going East-West and additional train starts going East-West with other commodities. So there is an optimal operation solution that allows them to surge and allows us to use some of that capacity that we've got existing today.

Okay. If already may not asked this, but is there a most favored nation clause in the contract that -- because you're obviously adding a lot of capacity in case of discounting?

Ian, we can't answer that question.

And look, you sold your Queensland terminal. In hindsight, was that a good idea?

Ian, for the price that we sell that terminal was an excellent idea, in hindsight.

And look, finally, what happened in flooding or track derailments, are you on the hook for providing the alternate service? Or is that a force majeure where it's back on them?

All the normal contractual arrangements and force majeure. Again, we won't get into specifics, one customer. But we're comfortable with that position. Absolutely.

[Operator Instructions] Your next question comes from Nathan Lead with Morgans.

Congratulations on the contract win guys. Just a couple of questions for me. So first up, I suppose, just dividends. You're obviously putting more capital into the ground now. So I just wanted to hear your thoughts on when you're sort of thinking about lifting up that dividend payout ratio, you're sort of talking about that being maybe an FY '25 event? Does this change things?

George, I might hand to you. It's quite restricted on what you can say but...

I am. And Nathan, I don't think we said when the dividend would be lifted because that would be predicting the future and pre-opting a Board decision. So we didn't say that last week. But what I would say is the additional capital here is $120 million on top of what we said last week. So it doesn't really change the capital profile significantly, but it does give us certainty of future revenue and earnings. So I would say it doesn't materially change that profile.

And secondly, 11-year contract term, more CapEx going in the ground, plenty of CapEx to support this. You talk about your IRR targets there. Can you maybe just talk through what you think in terms of terminal values when you're when you're considering this sort of like it's a capital budgeting sort of evaluation. So are you sort of thinking that you're fully recovering the capital across that period? Or you're giving some sort of risk to terminal base?

There is some risk at the back end, Nathan. And we do that because this is equipment that can be utilized in a multitude of other services. But I won't get into the specifics of how much of the capital is recovered over the period.

Your next question comes from Paul Butler with Credit Suisse.

Congratulations. Just a couple of questions. I presume that TGE ran a competitive process with this. So I was just wondering if you could comment on what your advantages in providing this type of service for them compared to the incumbent or anybody else who might have been in the process?

Paul, again, I think if you want to talk about the actual process that TGE, then you should talk to them. But consistent with every other contract that we've won, we win it on reliability and service.

So there's -- so I'm asking about what you think your advantages are, and not about what that process was. Is it just around the quality of the service you provide? Or do you have better access to any particular assets or anything that give you an advantage?

So Paul, I'll try again. We operate across the country in multiple jurisdictions, a reliable and safe service and reliability and service and good with good service quality. A reliable and high service quality are important to customers, and that is what we do better.

And just a couple of other ones. Clay, could I just get you to expand on -- I think you were saying the total markets nationally is $1 million to $1.1 million TEUs and a bit over -- about half of that is East-West. Could you break down the rest?

Yes. I think I started the headline number. And this is just our research and our strategy team and some work with consultants, et cetera, to try and figure out the size of the price and what the market will talk. So if you start at the top level, we think there's around $6 million TEU moving nationally. This is the kind of freight that TGE moved that other freight forwarders moved, about $6 million. Most of that is moving on the North-South between Melbourne, Sydney and Brisbane. But road has about 85% and the remaining is rail at 15%. So on the East-West, we think today, there is about 550,000 TEU moving east to west on rail. And we think total of that $6 million TEU is around $900 million to $1.1 million moving on rail of the $6 million.

Your next question comes from Scott Ryall with Rimor Equity Research.

But I'm just wondering what -- in terms of the CapEx spend on logos, wagons, those sort of things. What proportion do you think can be self-provided as opposed to purchase?

George, do you want to provide?

Yes. So Scott, when you look at the total CapEx for this contract, that $280 million, about $160 million of that is -- of the capital that we talked about last week and then another $120 million odd, which is terminal infrastructure and some specific wagons for this type of freight. I'm not going to get into the mix, though, of what of this will be new versus what it will be existing fleet. One of the things that I will say is that Andrew talked about winning this contract based on service and reliability, and so we're very focused on putting assets into this, which are going to deliver for the customer because that's how they will grow their volumes and we'll grow ours.

Just a follow-up, and this is my last question. Just a follow up on the service and reliability question. Do you guys -- when you sign a contract of this nature, and maybe mildly touched on it as well, do you warrant your service quality? And therefore, I remember not so long ago when you're doing Northern Queensland and there was some slight [indiscernible] but basically bring containers by -- containers in by road where you weren't able to access by rail. Is this the sort of contract that you will need to do that if something goes wrong with rail?

So I think you should look at -- Scott, I mean it's a good question. I think you should look at what TGE brings to the table, which is an enormous trucking capability, and we're providing sort of rail capability to it. So I think you're probably looking at that the wrong way around.

The other thing is, Andrew, I mean, TGE in this market today, and they're well aware of what happens with the network and how many times there's outages and how to respond to them. And that's what they bring to the table. And we bring to the table that sort of high safety, quality, customer focus that Andrew spoke about.

There are no further questions at this time, and that does conclude our conference for today. Thank you for participating. You may now disconnect.